Chief economist predicts two more rate cuts by year end

A prominent economist has forecast the cash rate to fall to 1.25 per cent by the end of 2016 due to record-low wages growth and a high Australian dollar.

AMP Capital chief economist Shane Oliver said that the Reserve Bank may choose to hold the cash rate next month, due to the extent to which the central bank has considered “waiting for more information”, indicated by the minutes from its May meeting.

“However, given the downside risks to inflation, particularly with wages growth falling to a record-low 2.1 per cent, constrained growth and the still-high Australian dollar, more rate cuts are likely,” he said.

“We are allowing for two more rate cuts this year, taking the cash rate to 1.25 per cent by year end.”

Since the RBA cut the cash rate to 1.75 per cent last month, Mr Oliver said some people have argued that the central bank should lower its inflation target because it cannot fight global commodity prices and should not worry about very low inflation.

“Such arguments are nonsense,” he said.

“First, the whole point of having an inflation target is to anchor inflation expectations. If the target is just raised or lowered each time it looks like being seriously breached, then those expectations – which workers use to form wage demands and companies use in setting wages and prices – will simply move up or down depending on which way the target is changed.

“And so inflationary or deflationary shocks from things like commodity prices will turn into permanent shifts up or down in inflation.”

Secondly, Mr Oliver said there are issues with allowing very low inflation.

“Most central bank inflation targets are set at 2 per cent or so because statistical measures of inflation tend to overstate actual inflation by 1 to 2 per cent, because statisticians have trouble actually adjusting for quality improvements, and so some measured price rises really reflect quality improvements,” he said.

“In other words, 1.5 per cent inflation could mean we are actually in deflation. And there are problems with deflation.”